With U.S. fiscal problems unresolved, treasured AAA rating may fall off cliff

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“Some respected voices on the left believe that a focus on the deficit is an overblown reaction to a manageable problem,” said David Hollingsworth, adviser for the Third Way, a centrist Democratic group that is pushing for further measures to reduce the deficit. “They argue that if our debt was really a big deal, investors wouldn’t be supplying us with capital so cheaply.”

Robert Shapiro, an economic adviser in the Clinton administration, advocates additional measures to gradually reduce spending on entitlement programs and bring down the deficit, but he blames the last downgrade on Republicans, not Democrats, and said it could happen again if conservatives insist on coupling an increase in the debt limit with unpopular spending reforms.

“The last time that House and Senate hyper-conservatives went down that path, it cost the U.S. government its triple-A rating from one of the three major credit-rating agencies,” he said, suggesting that Democrats will try to pin any further downgrades on Republicans if it happens again this year, and to use it to political advantage.

“Any political leader or party that helps to bring about such a catastrophe will prove themselves unfit to govern for a very long time,” he said.
Subhed.sans: Wall Street worries

The growing intransigence on the left and right has led many on Wall Street and Main Street to question whether another agreement delivering more budget cuts will emerge from the latest round of negotiations.

Tom Porcelli, chief economist at RBC Capital Markets, said he expects Republicans to fight hard for spending cuts that eluded them in last week’s deal, but the outcome is in doubt.

“In the absence of a grand bargain in the next two months, it is likely that the U.S. is downgraded,” he said. “And this downgrade is likely to have a more significant market impact than the S&P downgrade,” because it will force investment funds around the world to reshuffle the securities in their portfolios to ensure they are maintaining AAA or other targeted rating levels, he said.

This will cause widespread disruptions in global markets as investors recalibrate their portfolios, causing a “cascade effect” on assets other than Treasurys, he said.

John Browne, senior economic consultant at Euro Pacific Capital, said the damage from further downgrades would affect the U.S. status in the economic world for a long time.

The U.S. dollar is the world’s dominant currency, he said, because debt troubles in the eurozone have tarnished the appeal of the euro, which had been ascending as a replacement for the dollar in the past decade.

“This privileged position has conferred on Washington the vital element of time to organize viable revisions to its entitlements,” whose uncontrolled growth is at the root of the U.S. debt problem, he said. But political leaders appear to be “squandering” the luxury of time they got from the ongoing European debt crisis, he said.

“The spectacle of American politicians failing to agree on budgets, spending limits or any type of fiscal discipline can affect the credit rating of the U.S. Over the longer term, a major fall in the credit rating is likely to increase U.S. interest rates,” he said. But perhaps the greatest impact is to the U.S. reputation.

“The blatant dereliction of duty on display in Washington will diminish national prestige,” Mr. Browne said.

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